Delmar Financial

SAN DIEGO (CNNMoney.com) -- When Marcia Blackwell and her husband Tom founded Blackwell's Organic Gelato in 2005, they did what many small business owners do: They funded their efforts with a home equity line of credit. The interest rate was then about half that of a traditional business loan, even one backed by the Small Business Administration, and the money was available fast.

"It seemed like a smart business decision. I could get a line of credit and I didn't have to deal with the SBA scrutinizing me," says CEO Marcia Blackwell. She used the home equity line of credit, or HELOC, for just about everything for her Long Branch, N.J. business, from gelato ingredients and packing materials to the rent on space in a commercial kitchen.

Last October the company was doing well and seemed about six months away from becoming profitable, says Blackwell. That's when her bank called to say it was freezing the HELOC at $190,000 and would not allow her to use it any longer. She hadn't missed any payments, but that didn't matter. The bank's concern was that Blackwell's house had lost 30% of its value.

It was a financial wake-up call. Frugal to begin with, Blackwell cut costs even further and now keeps very little inventory on hand. Unable to stock up on supplies, she asks distributors to give her advance notice of big orders. "We have stopped all unnecessary spending, we cut out any marketing and advertising and I'm not paying myself," she says.

Blackwell's situation is not unique. Small business owners often use home-equity loans for liquidity, but now banks are freezing those lines of credit -- often without any notice. For businesses already running close to the edge, that can be a death knell.

Vino Pajanor, president of the Housing Opportunities Collaborative, a San Diego nonprofit that runs walk-in clinics and seminars for at-risk homeowners in southern California, estimates that 15% to 20% of those seeking help from the Collaborative are small business owners either in crisis or preparing for one.

"They used a home equity line for daily operation of the business and it's frozen," he says. "If they can't run the business, they can't make money to pay the mortgage, and it becomes a viscous cycle."

A $100,000 home-equity credit line helped the owner of a small auto parts dealership in New Jersey keep inventory stocked. A few months ago, that home equity line was frozen, says the dealer, who asked that his name not be used. "No reason whatsoever. We were making payments. They felt my net worth versus what was owed was too high," he says. "We cut our inventory by 40% and cut the number of trucks on the road in half. Now we are constantly paying more than we should for parts, because we can't buy ahead of time in bulk and get discounts."

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